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ECON10003 Chapter Notes - Chapter 9: Potential Output, Demand Shock, Observational Error

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salmonweasel666
31 Jul 2018
School
University of Melbourne
Department
Economics
Course
ECON10003
Professor
Nahid Khan, Lawrence Uren

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Document Summary

Aggregate demand and supply model: the aggregate demand aggregate supply model. Inflation inertia: in low-inflation industrial economies, inflation tends to change relatively slowly, public(cid:495)s inflation expectations. In negotiating future wages and prices both buyers and sellers take inflation into account. Inflation increases does not exceed the nominal wage/price increase real wage/price actually increases: the higher the expected rate of inflation the more nominal wages and the cost of other inputs will tend to rise. If inflation has been low and stable for some time people are likely to expect it to continue to be low, vice versa expectations will likewise tend to be volatile: long-term wage/price contracts. Firms have no incentive either to reduce or increase their prices relative to the prices of other goods no inflation changes: expansionary gap, actual output > potential output. Inflation increases: contractionary gap, actual output < potential output. If the inflation is rising faster than the expectation, the as curve shifts upwards/to the left.

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Related Questions

The AS/AD model is an excellent way to understand how specific policies and actions affect output and prices in an economy. Think about these questions as you discuss this topic:

What is the aggregate demand (AD) curve? What are the components of AD? What factors can shift the AD curve?

What is the difference between the long-run aggregate supply curve and the short-run aggregate supply curve?

What is MPC? How does the spending multiplier work?

Suppose that the Australian economy is at long run equilibrium, and the Australian government announces its decision to decrease spending on infrastructure.

Discuss the short-run effects of a decrease in spending on aggregate espenditure (AE) and aggregate demand (AD). in your discussion, explain the process that moves the economy to its new equilibrium output. That is, explain what would happen to:

1. aggregate planned expenditure

2. firms inventories and production

3. disposable income and consumption expenditure

4. aggregate demand and supply

5. real GDP and price level

Use the AE and AD Graph for your graphical analysis to support your explanation.

How does the policy rate hitting a floor of zero lead to an upward sloping aggregate demand curve?
 
A.When the policy rate hits a floor of the zero, the positive relationship between inflation and the real interest rate embodied by the MP curve becomes negative, and this reversal results in lower inflation producing a higher real interest rate, and hence lower planned spending, i.e., an upward-sloping AD
B.When the policy rate hits a floor of the zero, the negative relationship between planned spending and the real interest rate embodied by the IS curve becomes positive, and this reversal results in lower inflation producing a lower real interest rate, and hence lower planned spending, i.e., an upward-sloping AD curve.
C.When the policy rate hits a floor of the zero, the negative relationship between inflation and the real interest rate embodied by the MPcurve becomes positive, and this reversal results in lower inflation producing a higher real interest rate, and hence lower planned spending, i.e., an upward-sloping AD curve.
D.When the policy rate hits a floor of the zero, the positive relationship between inflation and the real interest rate embodied by the MP curve becomes negative, and this reversal results in higher inflation producing a higher real interest rate and hence a lower planned spending i.e. an upward-sloping AD curve.